How Much Can You Borrow Against Life Insurance?

Life insurance offers financial protection and security for loved ones. Beyond a death benefit, certain policies become a living asset, allowing access to accumulated funds during the policyholder’s lifetime. Understanding this feature provides financial flexibility.

Understanding Cash Value Life Insurance

Life insurance policies fall into two main categories: term life and permanent life. Term life provides coverage for a specific period (e.g., 10, 20, or 30 years) and does not build cash value. It offers a death benefit if the insured passes away within the term.

Permanent life insurance offers lifetime coverage as long as premiums are paid. This policy type includes a savings component, cash value, which accumulates over time. Common forms include whole life, universal life, variable universal life, and indexed universal life.

A portion of each premium paid into a permanent life insurance policy contributes to this cash value. This cash value grows on a tax-deferred basis, with earnings untaxed until withdrawal or policy lapse. Whole life policies offer guaranteed cash value growth at a fixed interest rate, sometimes with dividends. Universal life policies provide flexibility, with cash value growth tied to an adjustable interest rate or market index.

Calculating Your Borrowable Amount

The amount available for a policy loan ties directly to the accumulated cash value. Insurers allow borrowing a significant percentage, commonly 90% to 95%, meaning the entire cash value is not available.

The actual borrowable amount can be further influenced by several factors. Any existing outstanding policy loans or accrued interest on those loans will reduce the amount you can borrow. Additionally, some policies may have specific provisions or riders that affect the maximum loan amount.

It takes several years, often between two to ten or more, for a permanent life insurance policy to build sufficient cash value to support a substantial loan. The policy’s surrender value, which is the cash value minus any applicable surrender charges, determines the loan limit. Consulting with the insurer or a financial professional can clarify the precise amount available for a loan.

Applying for a Policy Loan

Accessing funds through a life insurance policy loan involves a straightforward process, as the cash value itself serves as collateral. Policyholders do not need to undergo a credit check or a lengthy approval process, unlike traditional bank loans. This makes policy loans an accessible source of funds.

To initiate a loan, the policyholder contacts their insurance provider directly. This can be done through a customer service representative, or via an online portal if available. The insurer will provide the necessary forms to complete the loan request.

Once the request and any required paperwork are submitted, the processing time for a policy loan is quick, ranging from a few business days to about ten business days. Funds can be disbursed through various methods, including a mailed check, direct deposit (EFT) into a bank account, or a wire transfer.

Managing Your Life Insurance Loan

After taking a loan against a life insurance policy, interest begins to accrue on the outstanding balance. This interest accrues daily and is charged at the policy’s anniversary date. Interest rates on policy loans are competitive and lower than those for personal loans or credit cards, ranging from 5% to 8%. They can be either fixed or variable.

A notable feature of life insurance policy loans is their flexible repayment structure. Unlike conventional loans, there is no fixed repayment schedule or mandatory payment dates. Policyholders can choose to repay the principal and interest over time, pay only the interest, or even choose not to repay the loan during their lifetime.

However, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries upon the insured’s passing. A significant risk arises if the loan balance, including accumulated interest, grows to exceed the policy’s cash value; this can lead to the policy lapsing. If a policy lapses with an outstanding loan, the amount of the loan exceeding the policyholder’s “cost basis” (total premiums paid) will be considered taxable income by the IRS. Certain policies classified as Modified Endowment Contracts (MECs) have different tax implications, where loans and withdrawals are taxable and subject to a 10% federal tax penalty if taken before age 59½.